Inflation persistence and monetary policy: DSGE-VAR approach

We study the dynamics of U.S. inflation persistence and the sources resulting to it over the “Great Inflation” and “Great Moderation” periods. It is different from most of the current studies in that we consider a Bayesian VAR model with the DSGE prior, the so-called DSGE-VAR approach, in which the prior economic information is coming from a small-scale New Keynesian DSGE model. In the recursive estimation of the model, we find a decline in the inflation persistence, measured by the “half-life” response of inflation to the monetary policy shock, in the early 1980s. The stance of monetary policy, particularly the aggressive attitude toward the monetary policy implementation, plays an important role in explaining the structural change of the inflation persistence.